iTunes Match viewed as break-even but important business for Apple

Though Apple's recently launched iTunes Match service isn't expected to be hugely profitable for the company, it is viewed as an important service that will further tie customers into the iTunes ecosystem and Apple's hardware.

Analyst Gene Munster with Piper Jaffray said on Thursday he believes the profitability of iTunes Match is similar to the iTunes Store, where Apple operates the business just above break-even. He thinks most of the $25-per-year subscription fee likely goes to music labels in the form of royalties, while the rest covers Apple's storage and delivery costs.

iTunes Match is currently available only to customers in the U.S., and Munster estimates there are about 135 million active iTunes users in America. If 1 percent of U.S. users were to buy iTunes Match for $25 per year, it would generate $33.8 million annually, while an an attach rate of 5 percent would amount to $169 million per year.

However, Munster said the revenue and profitability of iTunes Match are "immaterial," as the service won't contribute much to Apple's bottom line. That's similar to both the iTunes Store and the App Store, where the services are meant to support Apple's hardware rather than generate huge profits for the company.

Munster did raise the question of whether iTunes Match, which allows users to access music not purchased from the iTunes Store on a number of devices, would discourage users from buying higher-capacity devices. Hardware like the high-end 64GB iPhone carries a higher profit margin for Apple.

He noted that a survey of early adopters at the iPhone 4S launch found that 19 percent of buyers bought the 64GB model, and 32 percent bought the 32GB capacity.

"While we expect these numbers to come down from our survey of early adopters, the fact that 50% of buyers opted to pay up for more storage suggests that the advent of cloud-based access to content is not hampering sales of higher margin, higher capacity devices," Munster wrote.

"And while this mix may change, we still see benefits of higher capacity devices given the speed and convenience of local content, and limited access to the internet for some users (air travelers, for example)."

One estimate released in June found that Apple's iTunes Store and App Store cost the company about $1.3 billion a year to operate. Apple has maintained for years that its online services operate just above break-even, but serve to attract customers to its profitable hardware and accompanying ecosystem.

While iTunes Match will sync a user's library with songs available in iTunes and will automatically upload any tracks that are not found in Apple's online store, Apple does not yet have a way for users to upload videos they shoot on an iPhone or iPad to iCloud. Munster noted that video syncing and the ability to re-download movies purchased through iTunes remain two noticeable omissions from iCloud.

Munster sees that potentially changing in late 2012, when he expects Apple will launch its own full-fledged television set. As part of its TV offering, he sees Apple offering various bundles for live TV channels, potentially in the form of applications, along with access to previously aired shows on demand.

"The details of a subscription video service are very unclear, but we believe it would leverage Apple's iCloud infrastructure for web-based delivery of content to the television, or other iOS devices," he wrote. "And it would also likely start out small (perhaps offering just Disney/ABC content) while other content providers weigh the pros and cons of an Apple video service."

Munster did raise the question of whether iTunes Match, which allows users to access music not purchased from the iTunes Store on a number of devices, would discourage users from buying higher-capacity devices. Hardware like the high-end 64GB iPhone carries a higher profit margin for Apple.

Munster is likely wrong that it actually discourages buying since many folks pick their capacity by the number of apps they want to run and by video use, not audio.

Plus there's just the issue of available parts to actually go any higher. I'm not sure there are any at prices and sizes that will work for Apple's plans right now. So games like iTunes Match would profit the company by getting around the negative PR of the fact that Apple hasn't bumped any higher than 64 GB and maybe won't for another 2-3 iPad etc models.

If you've ever used iTunes Match, you'd understand why it's better. It all just works, all the time. I don't upload every song I get to the cloud, it's all just handled for me and streamed to me in high-quality AAC.

Music does not take a lot of storage. So, I don't see it be a big determinant in users selecting the GB capacity of their devices.

Video and Photos however take a VERY large amount of storage. With the new 1080P video capabilities and great new camera, it is going to drive substantial storage requirements. Especially as the iPhone 4S becomes people's primary camera. This could have, over time, a beneficial impact to Apples iPhone and iPad ASPs.

Regarding iTunes, I think the big story in the future is going to be how profitable it is. Apple at some point will have hundreds of millions of devices and users buying music, books, movies and apps. I have to believe there are substantial economies of scale, even with the payouts to the content providers. And, the gross profit margins on the incremental revenues is very large.

Apple is effectively going to own a large percentage of the newspaper, magazine, gaming, book, and software digital revenues worldwide. It's going to be a very big number.

I'd expect to start seeing revenues exponentially explode and for them to start communicating this story

Munster sees that potentially changing in late 2012, when he expects Apple will launch its own full-fledged television set. As part of its TV offering, he sees Apple offering various bundles for live TV channels, potentially in the form of applications, along with access to previously aired shows on demand.

This means that Apple will take a free ride on the CableCo's wires to deliver their product via broadband IP.

This means that Apple will be a huge proponent of Net Neutrality, or will likely suffer bandwidth problems with many owners of the last mile.

Given that Cable Co's have an oligopoly in pretty much every market they participate in, it is likely that they will raise their broadband prices as customers cancel their cable TV , but remain broadband customers.

This means that Apple will take a free ride on the CableCo's wires to deliver their product via broadband IP.

This means that Apple will be a huge proponent of Net Neutrality, or will likely suffer bandwidth problems with many owners of the last mile.

Given that Cable Co's have an oligopoly in pretty much every market they participate in, it is likely that they will raise their broadband prices as customers cancel their cable TV , but remain broadband customers.

They already do charge more. For instance, I have DirecTV. I have Internet and Phone through Charter. It was about $20-$25 cheaper for me to have a bundle that included the basic $10 cable package than it would have been to just pay for Phone/Internet. That is how they get around it.

Cable Cos, like magazines, rely on number of bodies/subscribers. The more potential bodies they have, the higher advertising dollars they can get.

The fact that they are launching into building new data farms despite having just completed one saysa it all about what Apple expects here. People who leave their favorite music, pics, and movies in Apple's care aren't thinking of going elsewhere for phones or computers, ever.

Apple's earnings come from hardware and some software, iTunes service operates break even. This is the magic of integrated, that is, distributed vendors, hardware, software and service must each make money. So Apple creates and enormous barrier to entry unless you can live on very lean margins by re-using infrastructure that is paid by other means, e.g., Amazon or you get a preferential break from content owners.

So it is unlikely Apple will mess up this model with TV. They sell products and if you want to make money selling TV OK, but if you want to make money as an intermediary [Google, Amazon, or MS TV content store] you need a different business model that makes money not from the Store, but related to the Store, e.g., advertising for Google.

Regarding iTunes, I think the big story in the future is going to be how profitable it is. Apple at some point will have hundreds of millions of devices and users buying music, books, movies and apps. I have to believe there are substantial economies of scale, even with the payouts to the content providers. And, the gross profit margins on the incremental revenues is very large.

Apple is effectively going to own a large percentage of the newspaper, magazine, gaming, book, and software digital revenues worldwide. It's going to be a very big number.

I'd expect to start seeing revenues exponentially explode and for them to start communicating this story

iTunes is already generating ridiculous profits. Apple reported more than USD $6 B in net sales from "Other music related products and services" for FY 2011 (Includes sales from the iTunes Store, App Store, and iBookstore in addition to sales of iPod services and Apple-branded and third-party iPod accessories). According to Apple:

"Net sales of other music related products and services were $6.3 billion in 2011, representing an increase of $1.4 billion or 28% compared to 2010. The increase was due primarily to increased net sales from the iTunes Store, which was largely driven by App Store expansion into new countries that contributed to strong growth in all of the Company’s geographic segments. During 2011, the combined net sales for the iTunes Store, App Store and iBookstore was $5.4 billion, representing an increase of 33% compared to 2010. The Company believes this continued growth is the result of heightened consumer interest in downloading third-party digital content, continued growth in its customer base of iPhone, iPad and iPod, expansion of third-party audio and video content available via the iTunes Store, and continued interest in and growth of the App Store. Net sales of other music related products and services accounted for 6% of the Company’s total net sales for 2011."

I believe Apple's emphasis on user experience is more appropriate than focusing on a product line. While Apple advertises iPhone, iPad and iPod these product lines are known (to Apple consumers) to be integrated into the Apple ecosystem. I consider iTunes to be a major aspect of the user experience which appears, to me, to be the focus of their advertising strategy. iTunes and iCloud are the value proposition for Apple products, if Apple (strongly) independently advertised their ecosystem then the focus is removed from their primary sales drivers (hardware) to services. Apple is, first and foremost, a consumer electronics company and will likely remain so since Apple is able to differentiate their products in ways their competitors can't imagine (primarily through control of exceptional design, manufacturing processes and amazing software).

Whatever their plans are, they need to fix the many many bugs in Match, and fast. Aside from the matching software not working particularly well, there's a lot of broken functionality, things that work fine with the old syncing that don't once Match is enabled. It's funny to see "it just works" comments about Match when that's been the opposite of my experience.

One example - smart playlists on iOS devices ignoring the "limit to X", and no smart playlists can reference other playlists. Come on, that's basic stuff people have been using for years.

"Though Apple's recently launched iTunes Match service isn't expected to be hugely profitable for the company, it is viewed as an important service that will further tie customers into the iTunes ecosystem and Apple's hardware."

If you've ever used iTunes Match, you'd understand why it's better. It all just works, all the time. I don't upload every song I get to the cloud, it's all just handled for me and streamed to me in high-quality AAC.

This

Quote:

Originally Posted by SolipsismX

You can upload 128Kbps MP3s and then re-download 256Kbps AAC with Google's service?

This

Quote:

Originally Posted by cajun

iTunes Match "blesses" all of your bootleg MP3's and gives you legal covering.

This

Oh- and I can use it on my Apple TV. If Google's cloud can do all of this, I'm all ears. Otherwise- $25... which is nothing.... is worth it to me for the better convenience and better quality.

Not to mention- if you have several songs that are less than 256Kbps music, you can always buy iTunes Match for one year, and upload all the music to Google Music at 256Kbps... nothing is stopping you.

I'm to the point in my life that I can pay a minuscule charge of $2/month for convenience. Some aren't.